EURO-CURRENCY MARKET

EURO-CURRENCY MARKET

A PROJECT

in the subject of Economics of Global Trade & Finance

SUBMITTED TO

UNIVERSITY OF MUMBAI

FOR SEMESTER -II OF

MASTER OF COMMERCE

BY.

KHAN MOHD.MOHSIN

Roll No.(14)

Specialization: Business Management

UNDER THE GUIDANCE OF

PROF. K VENKATESWARLU/

DR. AARTI PARSAD

YEAR - 2014-15

DECLARATION BY THE STUDENT

I, Shri Khan Mohd. Mohsin, student of M. Com. Part-I Roll Number (14), at the Department of Commerce, University of Mumbai do hereby declare that the project titled,

Euro-Currency Market submitted by me in the subject of Economics of Global Trade & Finance for Semester II during the academic year 2014-15, is based on actual work carried out by me under the guidance and supervision of Prof. K.Venkateswarlu/ Dr Aarti Prasad

I further state that this work is original and not submitted anywhere else for any other examination.

Date

Mumbai

Signature of Student

EVALUATION CERTIFICATE

This is to certify that the undersigned have assessed and evaluated the project on Euro-Currency Market in the subject of Economics of Global Trade & Finance submitted by Kum/Smt/Shri Khan Mohd. Mohsin , student of M. Com. Part-I at the Department of Commerce, University of Mumbai for Semester II during the academic year 2013-14.

This project is original to the best of our knowledge and has been accepted for Internal Assessment.

Internal Examiner External ExaminerDirector

Dr. V. Deolankar

University of Mumbai

Department of Commerce

Internal Assessment: Subject: Economics of Global Trade & Finance

Name of Student

Class

Branch

Roll Number

First Name : MOHD MOHSIN

Fathers : MOHD MOIN

Surname : KHAN

M.COM

PART -I

Business Management

14

Topic for the Project: Euro-Currency Market

Marks Awarded

Signature

DOCUMENTATION

Internal Examiner

(Out of 10 Marks)

External Examiner

(Out of 10 Marks)

Presentation

(Out of 10 Marks)

Viva and Interaction

(Out of 10 Marks)

Total Marks

(Out of 40 Marks)

CONTENT

SL.NO.

PARTICULARS

PAGE NO.

CHAPTER 1 - INTRODUCTION

1.1

Introduction of International Financial Markets

1-3

1.2

Currency Markets

4-5

1.3

Historical Background Of International Financial Markets

6-10

CHAPTER 2 - UNDERSTANDING THE CONCEPT

2.1

Introduction of Euro-currency Market

11-12

2.2

Historical Background of Euro-currency

13-15

2.3

Definitions of Eurocurrency or Eurocurrency market

16

2.4

Characteristics of the Euro-currency Market

17-18

2.5

Reasons for Development of the Euro-currency Market

19-21

2.6

Creation of Euro-currencies and deposits

22

2.7

Instruments of the Euro-currency Market

23

CHAPTER 3 - THE FUTURE

3.1

Economic impact of Euro-currency Market

24

3.2

Advantages of Euro-currency Market

25

CHAPTER 4 - SUMMARY OF STUDY

4.1

Conclusion

26

4.2

Summary of Euro-currency Market

27

4.3

Abbreviation

28

4.4

Bibliography

29

EURO-CURRENCY MARKET

CHAPTER 1

1.1 INTERNATIONAL FINANCIAL MARKET

Introduction (International Financial Market)

International financial market serve as links between the financial markets of the each individual country and as independent market outside the jurisdiction of any one country.

The market for currencies is the heart of this international financial market. International trade and investment are often denominated in a foreign currency. So the purchase of the currency precedes the purchase of goods, services, or assets.

The growth of the foreign currency markets in Europe in the 1960s was one of the first developments in the movement towards the globalization of the financial market. Prior to 1980 euro-currencies markets was the only truly international financial market of any importance. Eurodollar or Eurocurrency markets are the international currency markets where currencies are borrowed and lent. Each currency has demand and a supply. The demand for foreign currencies arises when tourists visits another country and need to exchange their national currency for the currency of the country they are visiting, when a domestic firm wants to import from another country,when an individual wants to invest abroad and so on. On the other hand, expenditures in the country arises from foreign tourists expenditures in the country, from export earnings, from foreign investments in the country and so on.

The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies . The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. Electronic Broking Services (EBS) and Reuters 3000 Xtra are two main interbank FX trading platforms. The foreign exchange market determines the relative values of different currencies.

The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as dealers, who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the interbank market, although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states, especially Euro zone members, and pay euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.

In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

The foreign exchange market is unique because of the following characteristics:

Its huge trading volume representing the largest asset class in the world leading to high liquidity;

Its geographical dispersion;

Its continuous operation: 24 hours a day except weekends, i.e., trading from 20:00 GMT on Sunday until 22:00 GMT Friday;

The variety of factors that affect exchange rates;

The low margins of relative profit compared with other markets of fixed income; and

The use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks.

According to the Bank for International Settlements , the preliminary global results from the 2013 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets Activity show that trading in foreign exchange markets averaged $5.3 trillion per day in April 2013. This is up from $4.0 trillion in April 2010 and $3.3 trillion in April 2007. FX swaps were the most actively traded instruments in April 2013, at $2.2 trillion per day, followed by spot trading at $2.0 trillion.

1.2 CURRENCY MARKETS

International currency markets are the markets for foreign currencies where the currencies are borrowed and lent for varying maturities. The prices paid for borrowing or lending a currency in the international currency markets is the rate of interest.

The international currency markets are the adjunct of the foreign exchange markets. The foreign exchange markets one currency is exchanged for another currency at a rate of exchange which is the rate at which the currency of a country is exchanged against the currency of another country. The purpose for which currencies are exchanged in the foreign exchange market or borrowed in the currency may be the same, namely, for investment or for meeting trade and payments requirements, or for short-term or long-term investment or for meeting debt or other obligations. Foreign exchange market and the currency market are interrelated.

Foreign currency market structure:

The market for foreign currencies is a worldwide market that is informal in structure. This means that it has no central placed like stock exchanges. Themarket is actually the thousands of telecommunications links among financial institutions around the world. Its is open 24 hours a day. Someone, somewhere,is nearly always open for business. For example, the subscribers to international financial news sources, such as Reuters news network, are connected to spot exchange computer screen. The screen serves as a bulletin board, where all financial institutions wanting to buy or sell foreign currencies can post representative prices.

Although, the rates quoted on these computer screen are indicative of current prices, the buyer is still referred to the individual bank for the latest quotation due to the rapid movements of rates world wide. There are also hundreds of banks operating in the markets at any moment that may not be listed on the brief sample of Reuters new bulletin,

The speed with which this market moves, the multiplier of players playing on a field that is open 24hours a day, and the circumference of the earth with its time and days differences procedure many different single prices.

Foreign currency market is the largest and most liquid financial market in the world. It includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions.

Eurocurrency Spreads

A number of fundamental factors explain the smaller spread in the Eurocurrency markets.

1. Operations: It is a wholesale market; It typically operates in units of $1 million; It services large and well-known clients; All these lead to low overhead cost.

2. Regulations: No deposit insurance; Market interest on voluntary reserves; tax incentives.

3. Asset-liability management: Clients are known with high-quality credits smaller default risk; Floating rate interest + maturity matching r educed interest rate risk; No prepayment risk.

1.3 HISTORICAL BACKGROUND OF INTERNATIONAL FINANCIAL MARKETS

(i) Ancient

Currency trading and exchange first occurred in ancient times. Money-changing people, people helping others to change money and also taking a commission or charging a fee were living in the times of the Talmudic writings (Biblical times). These people (sometimes called "kollybists") used city-stalls, at feast times the temples Court of the Gentiles instead. Money-changers were also in more recent ancient times silver-smiths and, or, gold-smiths.

During the fourth century the Byzantium government kept a monopoly on the exchange of currency.Currency and exchange was also a crucial element of trade in the ancient world so that people could buy and sell items like food, pottery and raw materials. If a Greek coin held more gold than an Egyptian coin due to its size or content, then a merchant could trade fewer Greek gold coins for more Egyptian ones, or for more material goods. This is why the vast majority of world currencies are derivatives of a universally recognized standard like silver and gold.

(ii) Medieval and later

During the fifteenth century the Medici family were required to open banks at foreign locations in order to exchange currencies to act for textile merchants. To facilitate trade the bank created the nostro (from Italian translated "ours") account book which contained two columned entries showing amounts of foreign and local currencies, information pertaining to the keeping of an account with a foreign bank. During the 17th (or 18th ) century Amsterdam maintained an active forex market. During 1704 foreign exchange took place between agents acting in the interests of the nations of England and Holland.

(iii) Early modern

The firm Alexander Brown & Sons traded foreign currencies exchange sometime about 1850 and were a leading participant in this within U.S.A. During 1880 J.M. do Esprito Santo de Silva (Banco Esprito e Commercial de Lisboa) applied for and was given permission to begin to engage in a foreign exchange trading business.

1880 is considered by one source to be the beginning of modern foreign exchange, significant for the fact of the beginning of the gold standard during the year.

Prior to the first world war there was a much more limited control of international trade. Motivated by the outset of war countries abandoned the gold standard monetary system.

(iv) Modern to post-modern

From 1899 to 1913, holdings of countries' foreign exchange increased at an annual rate of 10.8%, while holdings of gold increased at an annual rate of 6.3% between 1903 and 1913.

At the time of the closing of the year 1913, nearly half of the world's foreign exchange was conducted using the Pound sterling. The number of foreign banks operating within the boundaries of London increased in the years from 1860 to 1913 from 3 to 71. In 1902 there were altogether two London foreign exchange brokers. In the earliest years of the twentieth century trade was most active in Paris, New York and Berlin, while Britain remained largely uninvolved in trade until 1914. Between 1919 and 1922 the employment of a foreign exchange brokers within London increased to 17, in 1924 there were 40 firms operating for the purposes of exchange. During the 1920s the occurrence of trade in London resembled more the modern manifestation, by 1928 forex trade was integral to the financial functioning of the city. Continental exchange controls, plus other factors, in Europe and Latin America, hampered any attempt at wholesale prosperity from trade for those of 1930's London.

During the 1920s foreign exchange the Klein-wort family were known to be the leaders of the market, Jap-hets, S,Montagu & Co. and Seligman's as significant participants still warrant recognition. In the year 1945 the nation of Ethiopia's' government possessed a foreign exchange surplus.

(v) After World War II

After World War II, the Bretton Woods Accord was signed allowing currencies to fluctuate within a range of 1% to the currencies par. In Japan the law was changed during 1954 by the Foreign Exchange Bank Law, so, the Bank of Tokyo was to become because of this the Centre of foreign exchange by September of that year. Between 1954 and 1959 Japanese law was made to allow the inclusion of many more Occidental currencies in Japanese forex.

President Nixon is credited with ending the Bretton Woods Accord, and fixed rates of exchange, bringing about eventually a free-floating currency system. After the ceasing of the enactment of the Bretton Woods Accord (during 1971 ) the Smithsonian agreement allowed trading to range to 2%. During 196162 the amount of foreign operations by the U.S. of America's Federal Reserve was relatively low. Those involved in controlling exchange rates found the boundaries of the Agreement were not realistic and so ceased this in March 1973, when sometime afterward none of the major currencies were maintained with a capacity for conversion to gold, organizations relied instead on reserves of currency. During 1970 to 1973 the amount of trades occurring in the market increased three-fold. At some time (according to Gandolfo during FebruaryMarch 1973) some of the markets' were "split", so a two tier currency market was subsequently introduced, with dual currency rates. This was abolished during March 1974.

Reuters introduced during June 1973 computer screen, replacing the telephones and telex used previously for trading quotes.

(vi) Markets close

Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float the forex markets were forced to close sometime during 1972 and March 1973. The very largest of all purchases of dollars in the history of 1976 was when the West German government achieved an almost 3 billion dollar acquisition (a figure given as 2.75 billion in total by The Statesman: Volume 18 1974), this event indicated the impossibility of the balancing of exchange stabilities by the measures of control used at the time and the monetary system and the foreign exchange markets in "West" Germany and other countries within Europe closed for two weeks (during February and, or, March 1973. Giersch, Paqu, & Schmieding state closed after purchase of "7.5 million Demarks" Brawley states "... Exchange markets had to be closed. When they re-opened ... March 1 " that is a large purchase occurred after the close).

(vii) After 1973

In fact 1973 marks the point to which nation-state, banking trade and controlled foreign exchange ended and complete floating, relatively free conditions of a market characteristic of the situation in contemporary times began (according to one source), although another states the first time a currency pair were given as an option for U.S.A. traders to purchase was during 1982, with additional currencies available by the next year.

On 1 January 1981 (as part of changes beginning during 1978 ) the Bank of China allowed certain domestic "enterprises" to participate in foreign exchange trading. Sometime during the months of 1981 the South Korean government ended forex controls and allowed free trade to occur for the first time. During 1988 the countries government accepted the IMF quota for international trade.

Intervention by European banks especially the Bundesbank influenced the forex market, on February the 27th 1985 particularly. The greatest proportion of all trades world-wide during 1987 were within the United Kingdom, slightly over one quarter, with the U.S. of America the nation with the second most places involved in trading.During 1991 the republic of Iran changed international agreements with some countries from oil-barter to foreign exchange.

FOREIGN EXCHANGE MARKET TURNOVER

CHAPTER 2

2.1 EUROCURRENCY MARKETS

Introduction

Eurocurrency refers to commercial bank deposits outside the country or their issue. Thus, any currency internationally supplied and demanded and in which a foreign bank is willing to accept liabilities and loan assets is eligible to become Eurocurrency. For example, a US dollar deposit held in London or Paris is a Euro-dollar deposit. A Deutschemark deposit held in New York, London, and Paris is a Euro-mark deposit. Similarly, a pound sterling deposit in a French Commercial bank or in a French branch of a British bank is Eurosterling, and so on. These balances are usually borrowed or loaned by major international corporations,and governments when they need to acquire or invest additional funds.

The market in which borrowing and lending in euro-currency takes place is called the Euro-currency market. It has two sides to it, that is the receipt of deposits and the loaning of that deposits.

The prefix Euro is now outdated because such deposits and loan in different currencies are regularly traded outside Europe, especially in Singapore and Hongkong. Thus, Euromarkets are also referred to as offshore market if such deposits have more widespread geographical base.

The most important Euro-currency is Eurodollar. It is followed by the Euro-mark, Euro-franc (Swiss), Eurosterling and Euro-yen, Initially, only the dollar was used in this fashion, and the market was therefore called the Eurodollar market. Subsequently, the other lending currencies such as the German mark, the Japanese Yen, the British pound sterling, and the French and Swiss franc, also began to be used in this way. Thus, the market is now called the Eurocurrency market. The main reason for the rapid growth of Euro-currency markets is that they provide better deposit and loan rates than offered by domestic banks located in the country that issues the currency.

Eurodollars are deposit liabilities, denominated in US dollars,of banks located outside the United States and trade in Europe. The basic characteristics of Eurodollars are that;

(i) They are short-term obligations of banks to pay US dollars, and

(ii) These banks are located outside the U.S.

The banks themselves need not be be foreign. They are often European nationality. The depositors range from European centrals banks, firms and individuals to US banks, Corporations and residents.

The term Eurodollar came to be used because the market had its origin and earlier development with dollar transactions in the European money markets. When the European bank expanded their operation to accept deposits and make loans in currencies other than the dollar the more general terms such as Euro-currency and Euromarkets came into use. With the spread of the practice of the accepting deposits in dollar and other foreign currencies to other parts of the world, such as Hongkong and Singapore, the terms such as Eurocurrency and Euromarket have also become misleading.

The practice of keeping bank deposits denominated in a currency other than that of the country in which the deposits is held has also spread to non-European international monetary centers as Tokyo, Hongkong, Singapore and Kuwait and they are appropriately called Offshore deposits. The name Euro-deposits is often used also for such deposits outside Europe. With these geographical extensions, the Eurocurrency market has become an essentially 24-hour a day operation.

2.2 HISTORICAL BACKGROUND OF EURO-CURRENCY

After World War II, the amount of US Dollars outside the United States increased enormously, both as a result of the Marshall Plan and as a result of imports into the USA. As a result, large sums of US Dollars were in custody of foreign banks outside the United States. Many foreign countries, including the Soviet Union, had deposits in US dollars in USA banks.

After the invasion of Hungary in 1956, the Soviet Union feared that its deposits in American banks could be frozen as retaliation. A British bank offered the Soviets the possibility of receiving its US Dollar reserves as deposits, outside the USA. This operation was considered the first to create so-called Eurodollars.

Gradually, as a result of the successive commercial deficits of the United States, the Eurodollar market expanded until today where it is available in virtually every country. Today, Eurocurrency refers to deposits in any currency residing in banks that are located outside the borders of the currencys country. For example a deposit denominated in Yen residing in an Australian bank is a Eurocurrency deposit, or more specifically a Euro-Yen deposit. Similar external deposits apply to Euro-Sterling, Euro-Euro, Euro-Swiss Franc, etc.

A Eurocurrency market is a money market that provides banking services to a variety of customers by using foreign currencies located outside of the domestic marketplace. The concept does not have anything to do with the European Union or the banks associated with the member countries, although the origins of the concept are heavily derived from the region. Instead, it represents any deposit of foreign currencies into a domestic bank. For example, if Japanese yen is deposited into a bank in the United States, it is considered to be operating under the auspices of the Eurocurrency market.

This market has its roots in the World War II era. While the war was going on, political challenges caused by the takeover of the continent by the Axis Powers meant that there was a limited marketplace for trading in foreign currency. With no friendly government operations within the European marketplace, the traditional economies of the nations were displaced, along with the currencies. To combat this, especially due to the fact that many American companies were tied to the well-being of business behind enemy lines, banks across the world began to deposit large sums of foreign currency, creating a new money market.

One of the factors that make the Eurocurrency market unique compared to many other money market accounts is the fact that it is largely unregulated by government entities. Since the banks deal with a variety of currencies issued by foreign entities, it is difficult for domestic governments to intervene, particularly in the United States. With the establishment of the flexible exchange rate system in 1973, however, the U.S. Federal Reserve System was given powers to stabilize lending currencies in the event of a crisis situation. One problem that arises is that these crises are not defined by the regulations, meaning that intervention must be established based on each case and the Federal Reserve must work directly with central banks around the world to resolve the matter. This adds to the volatility of the market.

Despite its name, the Eurocurrency market is primarily influenced by the value of the American dollar, since nearly two-thirds of all assets around the globe are represented by U.S. currency. The challenge with foreign banks revolves around the fact that regulations enforced by the Federal Reserve are really only enforceable within the U.S. The taxation level and exchange rate of the American dollar varies depending on the nation; for example, an American dollar in Vietnam is worth more than it is in Canada, further influencing the market.

The origin of the Eurocurrency market can be traced back to the 1950s and early 1960s, when the former Soviet Union and Soviet-bloc countries sold gold and commodities to raise hard currency. Because of anti-Soviet sentiment, these Communist countries were afraid of depositing their U.S.

Dollar in U.S. Bank for fear that the deposits could be frozen or taken. Instead they deposited their dollars in a French bank whose telex address was EURO-BANK. Since that time, dollar deposits outside the U.S. have been called Eurodollar and banks accepting Eurocurrency deposits have been called Euro-banks.

2.3 Definitions of Eurocurrency or Eurocurrency market

According to the book The current Levich textbook, The Eurocurrency market is the market for deposits placed under a regulatory regime different than the regulations applied to the deposits used to execute domestic transactions.

According to the Grabbe, The money market for borrowing and lending currencies that are held in the form of deposits in banks located outside the countries in which those currencies are issued as legal tender. Eurodollar: A dollar-denominated deposit in a bank outside the United States or at International Banking Facilities (IBFs) in the United States.

According to the Eiteman, Stonehill and Moffett, Eurocurrency: A currency deposited in a bank located in a country other than the country issuing the currency. Eurodollar: A U.S. dollar deposited in a bank outside the United States. A Eurodollar is one type of Eurocurrency.

According to the Gunter Dufey and Ian Giddy The International Money Market, The Eurocurrency market is simply a market for bank time deposits and loans denominated in a currency other than that of the country in which the bank is located. The international money market consists of the Eurocurrency market and its linkages to the major domestic money markets.

What are Eurodollars and Eurocurrencies?

According Maurice D. Levi, International Finance, Here is a short, accurate definition: A Eurodollar deposit is a U.S.-dollar-denominated bank deposit outside the United States. Eurocurrency deposits are a generalization of Eurodollars and include other externally held currencies.

2.4 CHARACTERISTICS OF THE EUROCURRENCY MARKET

The important characteristics of the Eurocurrency market are the following:

I. Free of government regulation: The Eurocurrency market is an important channel for mobilizing funds and deploying them on an international scale. The important centres are London, Paris, Hongkong and Singapore. It is generally outside the direct control of any government regulation.. More specially, they do not face compulsory reserve requirement interest ceiling on deposits and so on it is generally said that the dollar deposits in London are Outside the control of US because they are in London, and they are also outside the control of British government because they are in dollars.

II. Short-term nature: The deposits and loans of Eurobanks are Predominantly of a short-term nature. The maturity nature of some deposits is as short as one day and majority are under six months. Interest is paid on all of them. The Eurocurrency loans are generally for short period- three months or less.

III. Close maturity of assets and liabilities: There is a close matching of the maturity structure of assets (loans) and liabilities (deposits). This is due to the fact that Eurobanks have to be cautious about the sudden large withdrawal of short-term funds by the depositors. Further, the close matching of assets and liabilities reduce the risk of interest rate fluctuations to the banks. Here the deposits are for short-term and lending are the long-term. Therefore it is necessary to maintain a balance.

IV. Eurobanks themselves the users of Eurocurrency: A large proportion of Eurocurrencies are used by the Eurobanks themselves. Those Eurobanks with surplus funds loan to Eurobanks having lending possibilities but are short of funds. The other users of Eurocurrency market facilitate are non- Eurobank financial institutions, multinational corporation, international institutions, like World bank and government. World bank frequently borrows fund from Eurobanks for lending developing countries. Multinational Corporations are attracted by higher interest rates paid on their deposits and competitive borrowing rate.

V. Wholesale market: Eurocurrency market is a Wholesale market in the sense that their size of transactions is very large. Generally, the size of individual transaction is about $1 million. It is centered in London.

VI. Well organized, efficient and large market : Eurocurrency is well organized and very efficient. It serve a number of role for multinational business operation. It is an important and convenient device of multinational corporations to hold their excess liquidity. It is an important source of short-term loans to finance corporate working capital need and foreign trade. It is a large international money market.

2.5 REASONS FOR THE DEVELOPMENT OF THE EURO-CURRENCY MARKET

There are several reasons for the existence and spectacular growth of the

Eurocurrency market. They are as follows:

I. Soviets deposit of dollar in European banks: In the 1950s Soviet Union was earning dollars from the export of gold and raw materials. The Soviets did not want to keep them in the banks in the United States out of the fear that the US may freeze them due to the Cold War. The Soviets wanted dollar claims that were not subject to any control by the US government. The Soviets solved this problem by depositing their dollar earning with dollar-denominated deposits with banks in Britain and France. These Soviets deposits marked the birth of the Eurocurrency market.

II. Restrictions upon sterling credit facilities: In 1957, the Bank of England introduced restrictions on UK banks ability to lend sterling to foreigners and foreigners ability to borrow sterling. This induced the British banks to turn to the US dollars as an alternative means to finance the world trade. This provided a stimulus for the growth of the Eurocurrency market.

III. Abolition of the European Payments Union and Restoration Currency Convertibility: The European Payments Union (EPU) enabled the European member countries to settle trade credits among themselves with the minimum use of dollars. In 1958, EPU was abolished and convertibility of European Currencies was restored. Thus, European banks could hold US dollar without being forced to convert their central banks for domestic currencies. This provided another impetus to the growth of Eurocurrency market.

IV. US dollar as a key currency: The fundamental cause for the development of Eurocurrency market was the special position of the dollar as a key, or vehicle, currency. The dollar continues to be the main currency that is used to carry out the international transactions. Because of this special role of the dollar as a key currency, foreign individuals, corporation and governments preffered to hold dollar balances.

V. Regulation Q: In 1963, the US authorities introduced Regulation Q which fixed a ceiling on the interest rate that US banks could pay on time deposits. Since this regulation did not apply to offshore banks many US banks set up subsidiaries abroad to escape the banking regulations. Further, as the interest rates in Europe rose above the ceiling fixed by US authorities. Eurodollar deposits became more profitable than US deposits. This was another important causes for the rapid and sustained growth of Eurocurrency market. Euro banks are also not required to maintain minimum cash reserve with their central banks enabling them to lend more and earn more. In USA under regulation M such reserves are compulsory.

VI. Convenient to hold balances abroad: International corporation often found it very convenient to hold balances abroad for short periods in the country in which they needed to make payments. Since the dollar is the most important international and vehicle currency in making and receiving international payments, it is only natural a large proportion of the Eurocurrency to be in Eurodollars.

VII. Overcome Domestic Credit Restrictions: An important reason for the growth of the Eurocurrency market is that the international corporations can overcome domestic credit restrictions by borrowing in the Eurocurrency market.

VIII. Deposit of surplus funds by OPEC Countries: After the oil price increase of 1973, the OPEC countries began to deposit large amounts of dollars in European banks. The Eurocurrency markets experienced phenomenal growth after 1973. The OPEC countries also did not want to keep their dollar deposits in the United States for the fear that US government might freeze them in a political crisis. This is exactly what happened to the (small-proportion of the) dollar deposits that Iran and Iraq kept in the US during the US conflict with these countries in the late 1970s and early 1980s, respectively. The Eurobanks helped to recycle the surplus funds from OPEC countries to the deficit oil importing countries.

European banks are willing to accept deposits denominated in foreign currencies and are able to pay higher interest rates on these deposits than US banks because they can lend these deposits at higher rates. However, the spread between lending and borrowing rates on Eurocurrency deposits is smaller than that of US banks. Thus, European banks are often able to pay higher deposits rates and lend at lower rates than US banks. This is the result of :

a) The fierce competition for deposits and loans in the Eurocurrency market,

b) The lower operating costs in the Eurocurrency market due to the absence of legal reserve requirements and other restrictions on Eurocurrency deposits.

c) Economies of scale in dealing with very large deposits and loans, and

d) Risk diversification.

2.6 CREATION OF EUROCURRENCIES AND DEPOSITS

Eurocurrencies are created when someone who owns convertible currencies, deposits them with a bank outside the countries of those currencies. The Eurocurrency market can potentially create Eurocurrencies in exactly the same way that commercial banks create money, that is, by making loans which are redeposited in the same banking system, Eurobanks can generate multiple expansion of Euro deposits on receiving a fresh injection of cash. In other words, deposits give rise to deposits which in turn give rise to deposit creation. This is almost like deposits creation in the domestic monetary system. In the case of domestic monetary system the cash reserve ratio is often statutorily fixed, while in the case of Eurobanks, the cash reserve ratio is voluntarily decided.

The Eurocurrency markets have the potential to create credit and yet remain unregulated. The rapid growth of the Eurocurrency markets in the 1960s and 1970s had coincided with rise in the inflation rates in the industrialized countries. According to some economists the growth of Eurocurrency markets was partly responsible for this, since the Eurobanks have the ability to create deposits.

2.7 INSTRUMENTS OF THE EUROCURRENCY MARKET

I. Time Deposits: A large part of money in the Eurocurrency market is held in fixed-rate time-deposits. The maturities of most of them range from one-week to six months. The bulk of Eurocurrency time deposits are interbank liabilities. They pay a fixed, competitively determined rate of return.

II. Certificates of deposits: Another important instruments is the Eurocurrency Certificates of Deposits(CD). A Eurocurrency CD is a negotiable receipt for a dollar deposit at a bank located outside the US. There also exist an active secondary market for Eurodollar CDs. This allows investors to sell Eurodollar CDs before the deposits mature. Eurodollar CDs are issued by banks to tap the market for funds and are commonly issued in denominations varying from $,250,000 to $5 million.

III. Eurodollar floating rate CDs (FRCDs) and Eurodollar floating rate notes (FRNs) : FRCDs and FRNs came into use as a means of protecting both borrower and lender against interest rate risk. By making their coupon (interest rate) payments float with market rate of interest, they help to stabilize the principal value of the paper. FRCDs are not very active now-a days.

IV. Note Issue Facilities (NIFs) : NIFs become a significant Eurodollar instrument in the mid-1980s. It is an arrangement between a borrower and an underwriting bank under which the borrower can issue short-term paper known as Euro-notes in its own name. Under such an arrangement, the under-writing bank is committed either to purchase any notes the borrower cannot sell or to provide standby credit. It is something like commercial paper programmes, the only difference being that it is with underwriting commitments.

Euro-Currency Interest Rate : Interest rates paid to the depositors and charged for loans is based on London Interbank Offered Rate (LIBOR). LIBOR is comparatively cheap as Euro banks operate with a small spread that is, the difference between deposits and lending rate. LIBOR rates are calculated as the averages of the lending rates in the respective currencies of leading London banks. At present, eight leading banks are not subject to restrictions by the Central banks, euro banks work with a smaller spread, that is, deposits are paid higher rate and loans are charged lower rate of interest.

CHAPTER 3

3.1 ECONOMIC IMPACT OF EUROCURRENCY MARKET

The emergence and the growth of Eurocurrency market and as its ability to create multiple expansion of credit without any apparent control mechanism have given rise to certain problems and advantages.

Problem

i. The important problem associated with it are :

ii. The Eurocurrency market facilities short-term speculative capital flows. This creates difficulties for central bank in their efforts to stabilize the exchange rates.

iii. The national monetary authorities lose effective control over monetary policy since domestic residents can make their efforts less effective by borrowing or lending abroad. Since Eurocurrency market contributes to increasing the degree of international mobility of capital. It makes monetary policy less effective. Eurocurrency market provides opportunities for avoiding many of the regulation that the monetary authorities try to enforce on domestic money market.

iv. Since the Eurocurrency market can be a source of international liquidity it can contribute to inflationary tendencies in the world economy.

v. The Eurocurrency market allows the central banks of deficit countries to borrow for balance of payments purpose. This may make these countries to postpone the needed balance of payments adjustments measures.

Originally, the Eurocurrency markets provoked fears among policymakers because the markets were growing extremely fast and there was no explicit regulatory supervision of the market. People feared that a loan default or panic withdrawals at one Eurobank could lead to a domino effect across other Eurobanks and perhaps threaten the integrity of the onshore banking system. Now economists feel that Euro-banking is less risky. It is understood that Eurobanks can operate at minimal risk by issuing term deposits matched by floating-rate loans. And the Basel Concordat has explicitly assigned the regulatory responsibility for Eurobanks should bankruptcy occur in any offshore branch.

3.2 ADVANTAGES OF EUROCURRENCY MARKET

Advantages:

Despite these problems arising from the growth of Eurocurrency market, it has given rise to many advantages.

I. It has helped to alleviate considerably the international liquidity problem.

II. It has provided credit to countries to finance the balance of payments deficits. In other words, it has played an important role in recycling funds from surplus to deficits countries.

III. It has helped to meet the short-term credit requirements of business corporations.

IV. It has provided a market for profitable investment of funds by commercial banks.

V. It has enabled the exporters and importers to obtain credit.

VI. This eurocurrency market has helped to accelerate the economic development of some countries like South Korea, Taiwan & Brazil.

VII. It has been largely responsible for the increased degree of financial integration between economies.

The Eurocurrency markets have become important sources of finance for governments and private firms.. The importance of Eurocurrency market is likely to grow with the growing integration of the world economy and globalization. Their competitive deposits and lending rates prove to be attractive for both both investors and borrowers of funds. At the same time, the growth Eurocurrency market has made monetary control more difficult for domestic authorities.

CHAPTER- 4

SUMMARY OF STUDY

4.1 Conclusion

International financial market serve as links between the financial markets of the each individual country and as independent market outside the jurisdiction of any one country.

The market for currencies is the heart of this international financial market. International trade and investment are often denominated in a foreign currency. So the purchase of the currency precedes the purchase of goods, services, or assets.

The market in which borrowing and lending in euro-currency takes place is called the Euro-currency market. It has two sides to it, that is the receipt of deposits and the loaning of that deposits.

The prefix Euro is now outdated because such deposits and loan in different currencies are regularly traded outside Europe, especially in Singapore and Hongkong. Thus, Euromarkets are also referred to as offshore market if such deposits have more widespread geographical base.

There is a reason of development of the Eurocurrency market are the following :-

Soviets deposits of dollar in European banks.

Restrictions upon sterling credit facilities

Abolition of the European payments Union and Restoration of Currency Convertibility

US dollar as a key Currency

Convenient to hold balances abroad

Overcome Domestic Credit Restrictions

Deposits of Surplus Funds by OPEC Countries

4.2 Summary of Eurocurrency Market

Eurocurrency refers to commercial bank deposits outside the country or their issue. Thus, any currency internationally supplied and demanded and in which a foreign bank is willing to accept liabilities and loan assets is eligible to become Eurocurrency.

For example, a US dollar deposit held in London or Paris is a Euro-dollar deposit. A Deutschemark deposit held in New York, London, and Paris is a Euro-mark deposit.

According to the Grabbe, The money market for borrowing and lending currencies that are held in the form of deposits in banks located outside the countries in which those currencies are issued as legal tender. Eurodollar: A dollar-denominated deposit in a bank outside the United States or at International Banking Facilities (IBFs) in the United States.

Creation of Eurocurrency Market.

In deposits give rise to deposits which in turn give rise to deposit creation. This is almost like deposits creation in the domestic monetary system. In the case of domestic monetary system the cash reserve ratio is often statutorily fixed, while in the case of Eurobanks, the cash reserve ratio is voluntarily decided.

Advantages:

Despite these problems arising from the growth of Eurocurrency market, it has given rise to many advantages.

It has helped to alleviate considerably the international liquidity problem.

It has provided credit to countries to finance the balance of payments deficits. In other words, it has played an important role in recycling funds from surplus to deficits countries.

It has helped to meet the short-term credit requirements of business corporations.

It has provided a market for profitable investment of funds by commercial banks.

It has enabled the exporters and importers to obtain credit.

ABBERVATION

Certificates of Deposits

(CD)

Electronic Broking Services

(EBS)

European Payments Union

(EPU)

Foreign Exchange

(Forex, FX,)

International Monetary Fund

(IMF)

International Banking Facilities

(IBFs)

London Interbank Offered Rate

(LIBOR)

Note Issue Facilities

(NIFs)

(OPEC)

5.1 Bibliography

Book and references journal

Economics of Global Trade and Finance (Published by Manan Prakashan in July 2013 )Johnson P.A., Mascarenhas A.D.

International economics, (Published by wath publishers, USA ) Robert C.Foenstra & Alan M.Taylor.

International Economics,(Published by S.Chand & Co) in Mithani & Jhingan.

Webilography

The official Website of Eurocurrency market www.authorstream.com

Investment site www.investopedia.com

The stanford university www.stanford.edu

Wikipedia www.wikipedia.com

$Google www.google.com

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